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According Atrill, P. and Mclaney (2011, p.2) book name as Accounting and finance for non-specialists states that "Accounting is concerned with collecting, analyzing and communicating financial information. The purpose is to help people who use this information to make more informed decisions. If the financial information that is communicated is not capable of improving the quality of decisions made, there would be no point in producing it. Sometimes the impression is given that the purpose of accounting is simply to prepare financial reports on a regular basis. While it is true that accountants undertake this kind of work, it does not represent an end in itself. The ultimate purpose of the accountant's work is to give people better financial information on which to base their decisions. This decision-making perspective of accounting fits in with the theme of this book and shapes the way in which we deal with each topic." Accounting information helps users to make better financial decisions. Users of financial information may be both internal and external to the organization.
Besides that, we need to describe 5 different users and their needs for Continental Limited financial statements and five regulatory characteristics of these financial statements that will provide useful information to the users. Therefore, prepare the income statement and balance sheet of Continental Limited for year ending 31 Dec 2010 in the internal use by company directors and management as well as external reporting or publication. Lastly, calculate the appropriate accounting ratios for year ending 31 Dec 2010 and compare them with industry averages provided to assess the profitability and liquidity of Continental Limited.
2.0 Findings of five regulatory characteristics and5 different users and their needs for Continental Limited financial statements
These characteristics define what makes financial statements useful to the users, such as: relevance, reliability, comparability, understandability and timely. Different accounting users are managers, employees, share or owner, creditor, customers, investors and government.
2.1 Five regulatory characteristics
One way of viewing accounting is as a form of service. Accountants provide economic information to their clients. There are other qualitative characteristics of financial statements, but those four are the most important, especially as they rely on fundamental assumptions like consistency and fair presentation.
Since financial statements are for users to make economic decisions, the information must be relevant to the decisions that those users have to make. The financial accounts prepared based on accounting concepts and policies should present relevant financial information which is capable of influencing the economic decision of the users. According to Atrill, P. and Mclaney (2011, p.2) book name as Accounting and finance for non-specialists states that "the role of accounting in confirming past events are important because users often wish to check the accuracy of earlier predictions that they have made and it may help users to judge the accuracy of current predictions." Therefore, relevant information must be timely.
Accounting should be free from significant error or bias. The financial accounts should present reliable information to the users for decision making. The financial account information is reliable, it reflects the substance of transaction to present faithfully and truly what has already happened and it is complete of required account information as well as it is prudent and realistic where there is any uncertainly. Similarly, that which is reliable may not be very relevant.
The financial accounts made based on accounting concepts should be comparable with the previous year accounts and comparable with the accounts of other companies. It will also help them to evaluate the performance of the business in relation to similar businesses. Comparability is achieved by treating items that are basically the same in the same manner for accounting purposes. Comparability may also be enhanced be making clear the policies adopted in measuring and presenting the information.
Accounting reports should be expressed as clearly as possible and should be understood by those at whom the information is aimed. The financial accounts prepared based on the accounting concepts should be capable of being understood by the uses that have reasonable knowledge of business, economic activities and accounting. Understandability ensures that a user equipped with the basic knowledge can discern information pertaining to the performance and financial position of an enterprise.
Whether the financial account information is relevant or not to the decision making of users, it depends on whether the financial accounts are made to present information in time or not when it is needed for decision making. If the accounts are prepared to provide required information in time, it is not relevant to decision making to users.
2.2 Five different users.
In accounting users, there are internal users and external users. Internal users means people within the organization, external users means people outside the organization, who use accounts to derive financial information for their needs follows.
2.2.1 Managers of the company
These are people appointed by the company's owners to supervise the day-to-day activities of the company. The accounts are the basis; the management can study the merits and demerits of the business activity. They need accounting information about the company's financial situation as it is currently and as it is expected to be in the future to enable them to manage the business efficiently and take effective control and planning decisions.
These are people employed by the company to carry out the business. Payment of bonus depends upon the size of revenue earned by the company. The more essential point is that the employees expect regular profits for the bread. The demand for wage rise, bonus, salaries better working conditions and other depend upon the profitability of the company and in turn depends upon financial situation.
2.2.3 Shareholders or owners
The owners provide funds or capital for the organization. These are business proprietors or the owners of the company. They need accounting information to assess how effectively the management of the company is performing its stewardship function, how profitably the management is running company's operations and how much profit they can withdraw from the business for their dividend payment.
2.2.4 Suppliers or creditors
These are people who provide trading good or services to the company on credit. It is usual that these groups are interested to know the financial soundness before granting credit. They need accounting information about the company's ability to pay its debts for ensuring their collection from the company. The development and prosperity of the company, two which credits are extended, are largely watched by creditors from the point of view of security and further credit.
2.2.5 Customer or debtors
These are people who purchase goods and services to the company on credit. They need accounting information about the company's financial stability to ensure that the company is a secure source of supply and no danger of having to close down.
They need accounting information about the business activities of the enterprises for the allocation of resources and national statistics. The state and central Governments are interested in the financial statements to know the earnings for the purpose of taxation. To compile national accounting is essential.
They need accounting information to know whether it is worth for them to invest their money in the business or buying shares of the company. Before investing, they are going through the financial statements of the firm. This is to safeguard the investment. For this, this group is eager to go through the accounting which enables them to know the safety of investment.
Besides understandability, reliability, relevance and comparability, other qualitative characteristics of information include completeness, prudence, neutrality, faithful representation and substance over form. Sometimes, there exists a trade-off between or among qualitative characteristics. The financial accountant usually exercises discretion where any conflict might occur.
3.0 Findings income statement and balance sheet for the internal use
Before answer task 2 the income statement and balance sheet, we need to calculate the following working for the note that information given us.
3.1 income statement and balance sheet for the internal use
Income statement is assessed by giving a summary of how the business incurs its revenues and expenses during equally operating and non-operating activities. It also shows the net profit or loss incurred over a definite accounting period, characteristically over a fiscal quarter or year. Balance Sheet is a statement of the financial position of a business which states the assets, liabilities, and owners' equity at a particular point in time. In other words, the Balance Sheet illustrates your business's net worth.
3.1.1Working for note (a) of question:
Closing stock should be recorded at cost or resale value which one is lower. Since cost RM65000 < net resale value RM70000, the cost RM65000 should be closing stock value put in the trading account of income statement and under the current asset in balance sheet.
3.1.2 Working for note (b) of question:
Sales (difference) 5000 Purchase 4000
Sales in trading account of income statement = RM 360000 from trial balance +RM 5000 =RM 365000.
Purchase in trading account of income statement =RM200000 from trial balance +RM4000 =RM204000.
Stationery as expense put in profit &loss account of income statement =RM700.
Electricity and water in profit and loss account of income statement =RM7000 from trial balance +RM 300 =RM7300.
3.1.3. Working for note (c) of question:
Sales commission as expense put in profit and loss of income statement =RM18000 paid from trial balance +RM15000 accrued at the end of the year= RM195000. Then, accrued sale commission RM1500 is recorder under the current liability in balance sheet.
Office salaries as expense put in profit and loss account of income statement= RM28000 paid from trial balance -RM2000 prepaid at end of year =RM26000. Then, prepaid office salary RM2000 is recorded under the current asset in balance sheet.
3.1.4 Working for note (d) of question:
Balance b/d 75000 (-) Bad debts 5000
Balance c/d 70000
Balance b/d 70000
Bad debts account
Debtor 5000 P/L account 5000
(Bad debts as expense put in P/L account)
Provision for bad debts closing balance = 10% x debtor closing balance RM70000= RM7000
Provision for bad debts account
Closing balance c/d 7000 Opening balance b/d 5000
Increase difference 2000
3.1.5 Working for note (e) & (f) of question:
Balance b/d 300000 Vehicle disposal account 5000
Balance c/d 250000
Balance b/d 250000
Provision for depreciation on vehicle account
Vehicle disposal account 12500 Opening balance b/d 6000
31 Dec 2010 Balance c/d 60000 Depreciation as expense put in P/L 12500
1Jan 2011 Balance b/d 60000
Vehicle disposal account
Vehicle cost sold 50000 Provision for depreciation on vehicle
Proceeds from disposal of vehicle 35000
Difference for loss on disposal
Of vehicle 2500
Provision for depreciation on premises account
Balance c/d 54000 Opening balance b/d 40000
Depreciation as expense 14000
3.1.6 Working for note (g) of question:
Taxation charge RM15300 is deducted from net profit at the bottom of income statement. It is also recorded as accrued taxation RM15300 under the current liability in balance sheet.
3.1.7 Working for note (h) of question:
Proposed dividend to be deducted from net profit at the bottom of income statement= 2% x RM500000 share capital from trial balance= RM10000. Then, the proposed dividend RM10000 is recorded under current liability in balance sheet
3.2 Income statement of Continental Limited for year ending 31 Dec 2010 for internal use
RM RM RM
Less return inwards (10000)
Net sales 355000
(-) Cost of sales:
Opening stock 50000
(+) purchase 204000
(-) return outward (15000)
(+) carriage inward 5000 194000
(-) closing stock (65000) 179000
Gross profit 176000
Dividend received 5000
Office electricity& water 7300
Office salaries 26000
Sales commission 19500
Bad debts 5000
Increase in provision for bad debts 2000
Loss on disposal of vehicles 2500
Depreciation on vehicles 12500
Depreciation on premises 14000
Vehicles expenses 12000
Interest charge 3000 104500
Net profit 76500
(-) taxation charge (15300)
(-) proposes dividend (10000)
Profit for the year 51200
(+) retained earnings brought forward 100000
Retained earnings carried forward 151200
3.3 Balance sheet of Continental Limited as at 31 Dec 2010 for internal use
RM RM RM
Fixed assets/Non-current assets
Office premises at cost 350000
(-) provision for depreciation on premises (54000) 296000
Vehicles at cost 250000
(-) provision for depreciation on vehicles (60000) 190000
Long-term investment 100000
Closing stock 65000
(-) Provision for bad debts (7000) 63000
Prepaid office salary 2000 172000
Issued share capital
Share capital 500000
Retained earnings carried forward 151200
Shareholders' equity 651200
(+) long-term liabilities/Non-current liabilities
(+) Current liabilities
Accrued sales commission 1500
Accrued taxation 15300
Proposed dividend 10000 51800
Based on the information that and after calculation, the total amount of income statement of Continental Limited for year ending 31 Dec 2010 for internal use is RM651200. And the balance sheet of Continental Limited for year ending 31 Dec 2010 is RM758000.
4.0 Findings income statement and balance sheet external reporting
In task 3 is about the income statement and balance sheet of Continental Limited for year ending 31 Dec 2010 in the accepted format for external reporting or publication. Before that, we need to follow classify the expenses from income statement of task 2 into distribution costs and administrative expenses as follows.
4.1 Distribution costs and administrative expenses
Distribution costs Administrative expenses
Stationery --- 700
Office electricity& water --- 7300
Office salaries --- 26000
Sales commission 19500 ---
Bad debts 5000 ---
Increase in provision for bad debts 2000 ---
Loss on disposal of vehicles 2500 ---
Depreciation on vehicles 12500 ---
Depreciation on premises --- 14000
Vehicles expenses 12000 ---
Total 53500 48000
4.2 Income statement of Continental Limited for year ending 31 Dec 2010 for external reporting
Cost of sales (179000)
Gross profit 176000
Distribution costs 53500
Administrative expenses 48000
Operating profit 74500
Dividend received 5000
Interest charges (3000)
Profit on ordinary activities before taxation 76500
Taxation charge (15300)
Profit on ordinary activities after taxation for the year 61200
Proposed dividend (10000)
Retained profit for the year 51200
Retained profit brought forward 100000
Retained profit carried forward 151200
4.3 Balance sheet of Continental Limited for the year ending 31 Dec 2010 for external reporting
RM RM RM
Long term investment 100000
Prepaid office salary 2000
Cash at bank 42000
(-) Creditors: Amounts Falling Due Within One Year
Accrued sales commission 1500
Accrued taxation 15300
Proposed dividend 10000
Net Current Assets 120200
Total Assets Less Current Liabilities 706200
(-) Creditors: Amounts Falling Due After More Than One Year
Capital and Reserves
Called up share capital 500000
Profit and Loss account 151200
Based on the information that and after calculation, the total amount of income statement of Continental Limited for year ending 31 Dec 2010 for external reporting or publication is RM151200. And the balance sheet of Continental Limited for year ending 31 Dec 2010 is RM651200.
5.0 Table of ration calculation
Ration with formula
Ration calculation for year 2010
Percentage of cross profit on sales
= Gross profit / Net profit x 100
176000 / 355000 x 100 = 49.57%
Percentage of operating profit on sales
= Operating / Net profit x 100
74500 / 355000 x 100 = 20.99%
Return on capital employed
(76500+3000)/706200 x 100% = 11.26%
= Current asset / current liabilities
172000 / 51800 = 3.32:1
Stock turnover period
= 365 days / stock turnover
365days/stock turnover in times
Debtors collection period
= Debtor ratio x 365days
63000 / 355000 x 365 days = 64.7 days
Creditor payment period
= creditor ratio x 365 days
25000 / 189000 x 365 days = 48.28 days
Working for (e)
Stock turnover = cost of sales / average stock value
= cost of sales / (opening stock + closing stock) / 2
= 179000 / (50000 + 65000) / 2
= 179000 / (115000/2)
= 179000/ 57500
Working for (f) = (debtor / net credit sales) x 365 days
= [63000 / (365000-10000)] x 365 days
= (63000 / 355000) x 365 days
= 64.7 days
Working for (g) = (creditor / net credit purchase) x 365 days
= (25000 / 189000) x 365 days
= 48.28 days
5.1 Profitability of Continental Limited
In the ratio calculation for year 2010, the percentage of gross profit on sales is 49.57%. It is high percentage than industry average 30% and the gross profit on the sales in ratio calculation for year 2010 is more effectively and efficiently than industry average in controlling its purchase cost by making the purchase at lower cost from supplier and efficient in controlling its production cost by the effective use of materials and labour to reduce its production cost rather than industry average. In the ratio calculation for year 2010, percentage of operating profit on sales is 20.99% which more than industry average that is 18%. From the ratio comparison, the higher expenses to sales ratio indicates that company is ineffective in its expenditure control causing higher expenses incurred to reduce its net profit earning. So that, the industry average ratio is lower expense to sales ratio indicates that company is effective in costs control causing lower expenses to incur to increase its net profit earning.
Return on capital employed (ROCE) in the industry average is 9%, in the ratio calculation for the year2010 is 11.26% where is higher than the industry average percentages. Higher net profit generated from the capital employed due to the effectiveness and efficiency of the capital employed in production and business activities. From the ratio comparison, the higher or increased return on capital employed indicates higher net profit generated from the capital employed for the effective use of capital employed in production and business activities to increase the production and sales volume as well as to increase the net profit earning.
5.2 Liquidity of Continental Limited
The comparison between the ratio for year ending 31 December 2010 and the industry averages which the former is higher than the latter. Conversely, the current ratio of the year ending 31 December 2010 is 3:.32: 1 higher than industry average which is 2:1, larger amount of current assets able to finance its short-term debts. The stock turnover period for the year ending 31 December 2010 is 117.36 days which more than the industry average because it only 90 days. From the ratio comparison, the higher or increased stock turnover and the shorter turnover period indicate fast stock turnover in business when goods purchased are kept in stock for long time and then slowly taken out for resale so that the stock is accumulated to tie up money, causing short term problem. The calculation ratio for the year end 31 December 2010 is 64.7 days which longer than the industry average which is 45 days only. From the ratio comparison, the higher or increases debtor ratio and the longer debtor's owing, causing longer time taken by company to collect money slowly from debtor so that larger debtor balance is accumulated to tie up money, bringing to shortage of money for paying back liabilities and facing short-term collection financial problem.
Lastly, the result ratio for year end 31 December 2010 is 48.28 days which is shorter than the industry average which is 60 days. Thus, the shorter creditor payment period indicate that company has obtained shorter credit time for owning and paying to creditors so that company needs to pay creditor in time, causing smaller creditor accumulated and short term financial problem for shortage of money to pay back creditor.
6.0 Conclusion and Recommendations
Different accounting user group looks at a business from a different perspective and has its own particular interests. . According to Atrill, P. and Mclaney (2011, p.4) book name as Accounting and finance for non-specialists states that" This means that there is always the risk that the interests of one group will collide with those of another group. Conflict between user groups is most likely to occur over the way in which the wealth of the business is generated and/or distributed."
In task 2, income statement and balance sheet of Continental Limited for year ending 31 Dec 2010 for internal use are RM651200 & RM758000.
In task 3, the total amount of income statement of Continental Limited for year ending 31 Dec 2010 for external reporting or publication is RM151200. And the balance sheet of Continental Limited for year ending 31 Dec 2010 is RM651200.
Tin task 4, the ration calculation is very important because it compares them and assesses the profitability and liquidity of Continental Limited. We understand the profit and loss as well as suggest management of future expansion policies.